Resoluteness – how to foster the rational conviction to swim undeterred against the stream

There is an ongoing battle since time immemorial between two seemingly immortal clans of mythic creatures. One sucks its sustenance daily (or nightly), while the other comes out once in a (blue) moon to feast on the weak.

I’m referring to respectively Buy And Hold investors on the one hand and Value investors on the other. The former just keep sucking away at cheap and expensive markets alike, whereas the latter wait for the lure of the full moon before making the effort to attack weak and abandoned companies trading below fair value.

Superstition aside, both investment models have nice track records. They have performed more or less equally well over the last 100 years.

The thing, however, is that even if they are comparable over longer time periods, their performance can differ significantly over half-cycles of, e.g., 5-10 years. An investor lacking the right conviction and resolve could be forgiven for switching from a Value Investing based strategy to Buy And Hold after a long bull market (such as today, in March 2017). He’s in good company. Well, in numerous company at least.

The curse of always being too early

Value investors typically buy too early on the way down and sell too early on the way up. VI investors thus miss out on the last run-up of a bull market, in particular any kind of manias. Thanks to avoiding large parts of downturns, a well calibrated VI system still captures a similar return over time as a BAH:er; with significantly less volatility and draw downs (in theory opening up for leverage).

To get the full benefit of either the VI or BAH style the investor needs to stick to the chosen model. The worst time to switch, by the way, is when your model has performed relatively poorly over several years. If both models are to keep producing the same long term returns, periods of underperformance are followed by overperformance.

At the peak of a bull market, valuations are too high for value investors, whereas BAH:ers couldn’t care less. Right when switching from the poorly performing VI model to the obviously better performing BAH model is the most appetizing, that’s when the timing is worst and your resolve is the only thing standing between you and a market timing disaster. BAH:ers on the other hand could get lucky if they unexpectedly decide to abandon their gleaming ship for the apparently decrepit VI system. Further, adherents of BAH shouldn’t switch half-way through a bull market, persuaded by the VI Cassandras’s cries of (were)wolf (too high P/E ratios) right when the real bull market party is about to get going.

Resoluteness: choosing a method and sticking to it

There are of course many other ways of investing. The point I’m trying to make is simply that, after some length of lean times it takes a certain kind of inner strength and tenacity even to stick to a system you “know” works. Making use of some of my earlier investment principles help in reinforcing that resolve.

Fear and greed should only happen to other people

Sticktoitiveness demands rational conviction

If you don’t know how your system works; if you don’t know why you’re using a certain method; if you don’t base your strategy on a logical and rational solid foundation, any conviction you started out with is both unwarranted and likely to be subject to erosion under pressure. The reason model based hedge funds don’t second guess their models during losing streaks is they trust whatever work they put in to create those models. Their conviction and resolve is rational, and they know it.

That kind of solid base is a prerequisite for lasting psychological strength in the face of financial and verbal insults.

Trust your well-defined and back tested method

enough to base your decisions on sound reasoning

and cold calculation

in pressing times

without second-guessing

-Trade only as scheduled

In my book about 15 years at the best performing hedge fund in Europe over a decade, I list 50 rules of investing.

This post is one in a line of articles detailing and explaining some of my most important insights from that time. Taken together I believe they will make for a useful and inspirational reminder for evolving and consistently improving your investment habits.

Whenever having a bad experience in the markets, or exhibiting signs of hubris after a lucky streak, refer back to these twelve ideas, thus combining your own experience with mine to maximize your investment wisdom.

Resoluteness means staying the course when the times get tough, when your funds are shrinking and you are being ridiculed by fair weather traders.

Resoluteness means swimming undeterred against the stream, secure in the conviction you have a strong strategy that works over time, the right risk management and patience to wait out temporary setbacks. In short, you have a system that insulates from biases, herding and sudden whims; and thus have the rationally based psychological strength that is a prerequisite for independent and successful investing.

Do you like the series? Do you know somebody that should read it? Tell them about it; share this post with them.

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